INVESTMENT ADVISER SRO – What makes sense. Part Three

Written by: Phil Feigin

We don’t need a new SRO for investment advisers. On top of that, a new SRO would be a marked detriment to the advisory profession, American investors and the economy. The essential reasons SROs arose in the first place are absent in the IA sector. What is needed is funding.

We’re already there where it counts most. FINRA already polices the advisory activities of those of its members who are dually registered as brokers and advisers. If FINRA is somehow limited in its oversight of dually functioning firms and reps, whatever those weaknesses are can be addressed easily in narrowly targeted legislation or rules.

In my view, it was a mistake way back whenever for the SEC, the states and the SROs to allow the Jekyll/Hyde arrangement of broker-IAs anyway. If you want to sell, be a broker; if you want to advise, be an IA, but they should not have allowed the two to be mixed. However, that cat’s long out of the bag. I think FINRA is well positioned to deal, i.e., to continue to deal, with the inherent and inescapable conflicts of interest that arise from the dual roles.

That said, I am pretty tired of the seemingly endless studies commissioned to find out if the investing public is confused about the differences between and the responsibilities of brokers and IAs. I am already on record as to my belief that the only real difference a uniform fiduciary duty would make is in customer arbitrations. There’s more persuasive state case law on fiduciary duty than there is on suitability.

Of course, people are confused. They are confused about all sorts of things. We have a Federal Trade Commission, Food and Drug Administration and state consumer protection laws, so those laser comb and other hair restoration technique and weight loss commercials rammed down my throat every night on TV and in newspaper ads (yes, I still read newspapers) must be legitimate, right? Certainly, if they weren’t legitimate, “they”—federal and state authorities—wouldn’t let them advertise. And then there are all the debt relief services that will help people under water keep all seven credit cards, their iPhones, premium cable, Lexus, gym memberships and Starbuck’s habits without sacrificing a thing, and for free; the companies that helped reduce that guy’s $5,000,000 tax liability from not filing returns since high school to $1,300; and the schools that teach people how to become real estate moguls, buying and selling houses risk free and without any money down; or pay off your mortgage in four months; or to day trade your way to millions. (Rant over.)

Are consumers really confused when they deal with an Ameriprise agent? Does the consumer really believe he will be offered a Merrill Lynch-sponsored mutual fund when he visits his Morgan Stanley rep? If you go to a Ford dealership, is anyone out there surprised when they are offered a Ford and not a new Audi? That they are confused by the differences between dealing with a broker and an IA is overly well-documented. But they are not confused about proprietary products.

For all the years I was Securities Commissioner, it was well-known that one of the NASD’s greatest fears, concerns and frustrations was that large producers at firms the NASD regulated were resigning, registering as investment advisers and placing their clients’ trades through accounts at Schwab or the like. It was apparently the NASD’s view that these reps turned advisers were then able to engage in violative conduct they could not engage in under the purview of the NASD.

We never quite knew what that wrongdoing was. Both NASD and IA regulation prohibited unsuitable recommendations. Neither the broker rep before nor the IA rep now could take custody of customer funds or securities. Both the broker rep and the IA rep could devise ways to steal from his customers. That was illegal under both regimes, yet, unfortunately, it still happened.

To us in the states, the IA model, particularly the fee-only model, freed the rep from having to sell stuff. Thus, the only (lawful) way for the IA to make money was if the client made money. The NASD feared losing control over the rep, but to us, a paramount basis for that control had been eliminated. Regulators, even self-regulators, always look over the river at the folks outside their regulatory grasp and seek more jurisdiction. It’s just the nature of the beast.

Show me the money. To me, FINRA has become nothing more than the securities regulatory version of private prisons. The perception is that hiring the private firm to build and run the private prison costs the government less than building and running its own facility. Maybe, maybe not. The functions FINRA now performs are all but indistinguishable from what OCIE, Trading and Markets, Enforcement and the states do, except they do more of it with their expanded resources. FINRA assesses/taxes its membership, which in turn “taxes” its clientele for the cost of that regulation. It is an off-book enterprise and off-book accounting that would make Enron’s Andrew Fastow proud. As for comparative cost to the investing public, one need only compare Mary Schapiro’s FINRA retirement package with whatever Arthur Levitt got as SEC Chair to get an idea as to how FINRA compensation compares to that of the SEC.

The SEC has tried, unsuccessfully, for years to become self-funded, i.e., to keep and spend what it takes in as fees. Under the plan, its fee levels would still be subject to Congressional control to prevent excesses. Relatively speaking, the amount the SEC estimates is needed to fully staff its inspection effort is miniscule in the grand scheme of the federal budget, and negligible when even the fees that would be required to pay for the increase are considered. Not a single additional tax dollar.

Yet, I am told, more money for the SEC is “off the table” in Congress. If that is the case, I say we should then get a new table. The costs of establishing an IA SRO will be astronomical in terms of what it will mean to day-to-day financial planners and their clients, to mutual fund advisors, their investors and their marginal returns since 2008. And for what? It is the SEC and the states that have been licensing and regulating advisers for more than 70 years. There is no legacy SRO as there was with the exchanges for brokers in 1934. And what will this new SRO, or heaven forbid, new SROs, be charged with doing? More inspections!

The SEC and states already have the granular body of IA “does and don’ts” rules and regulations. The belief is that more inspections will mean better oversight, catching the bad actors and improving the operations of the good ones. The regulators in place simply need more people. We do not need an industry/client-supported infrastructure, where the taxation and processes are hidden and largely uncontrolled.

Such a funding burden would all but surely take a punishing toll on a host of localized financial planners. Unlike the brokerage industry, fee-only financial planner practices are often one-person shops, managing $20 or $30 million with maybe 30 to 40 clients. The burdens posed in their having to support an IA SRO would be staggering. It may be more than they can withstand. The very people who are least likely to cause any IA-related problems would be the ones most hurt by the proposal. Per a survey in Massachusetts, 41% of its registered IAs would be driven from business.

Bait and switch? Surely, after winning jurisdiction in Dodd-Frank, the provision of the Bachus bill most offensive to state securities regulators is proposed section 203B(h). Under this unprecedented provision, state securities agencies—political arms of sovereign states—would, in essence, have to petition the IA SRO—a private company—and the SEC on an annual basis, in a report made at some sort of mandated (and no doubt unfunded) regulatory confab, for the power to regulate IAs within their jurisdictions. The petition would be based on the proposed “methodology of their examinations” for the coming year and how they did in meeting their goals the last year. NASAA, or something like NASAA—another private enterprise—is supposed to produce this report and itself make recommendations to the IA SRO and the SEC based on its vetting of how well the state agencies did and on state plans for the next year—another completely unfunded federal mandate. Based on the report and the confab, the IA SRO is to report to Congress each year. It is unclear in the bill, but I infer that, in this report, the IA SRO, with the advise and consent of the SEC, would determine conclusively which state either did not perform as planned last year, or whose plan is insufficient for the coming year, so that its state regulated investment advisers will be subject to IA SRO rather than state jurisdiction for the coming year. Not surprisingly, there is no provision for the states to submit their views as to how well or poorly the IA SRO performed last year or as to its methodologies for the coming year.

I can’t even begin to describe the constitutional problems the proposal entails, let alone the statutory and budgetary confusion and problems at all levels, for both regulators and regulated, it would cause were it to become law. It is just plain crazy.


First, leave state IAs to the states. Under Dodd-Frank, the states were given the responsibility of overseeing advisers with less than $100 million AUM. The states have been gearing up to fulfill that responsibility ever since, and commencement of the grand design is all but upon us. They should be given the chance to succeed. No matter what Congress does about the advisers under post-Dodd-Frank SEC jurisdiction, Congress should leave regulation of these state registered IAs alone. Revisit the system five years from now and see how they did.

Second, if necessary enhance FINRA’s existing jurisdiction. As I said before, do whatever might be necessary to enhance FINRA jurisdiction so it is fully empowered to regulate those entities dually registered as BDs and IAs as well as their people and the unique problems they all may present. The involvement of the states in regulating this sector likewise should be their business to prioritize and to coordinate with FINRA, as they do today. How much or little the SEC involves itself in overseeing this sector should be a matter of coordination and prioritization with FINRA and the states as well, again, as it is today.

Third, impose user fees to fund SEC oversight of SEC IA-only registrants. Finally, fund the SEC to inspect what is left is the third sector, the IAs that are not affiliated with any retail broker-dealer, that are registered with the SEC that do not sell securities, i.e., essentially, the money management sector, the managers of our mutual funds, hedge funds and institutional portfolios. I would include in this group those mutual funds that have brokerage affiliates. The potential risks posed to the economy by problems in this sector mandate direct SEC oversight.

The SEC must be given the authority to impose on these IAs the user fees necessary to fund their regular and efficient inspections and regulation. It is simply nonsensical for Congress to deny the SEC this funding mechanism in favor of establishing, staffing and inventing a new self-regulatory bureaucracy. How can anyone rationally compare the costs of establishing an entirely new and separate self-regulatory regime with those of simply adding additional staff to an already functioning system, and without spending an additional tax dollar?

In my last part in this series, I’ll share an anecdote about my own dabbling with the IA SRO concept as Securities Commissioner.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s